We get asked regularly by clients to tell them what their business is worth.

It’s a really hard question to answer. But also a very easy one. Let’s go for the easy (and lazy) answer first.

Your business is worth what someone is prepared to pay for it.

I told you it was easy and lazy as well.

That bit is obvious although many people forget that. They get embroiled in complicated calculation methods in order to come up with a value. But that doesn’t mean that there is anybody out there who is actually going to buy your business for that amount. Sometimes agents do this to get potential clients excited then once they have signed on the dotted line with the agent, they spend all their time talking the price down.

So how do we work out what somebody is really prepared to pay for your business?

Well there are a few key elements to this.

First of all, you need to think about who the potential buyers for your business are likely to be. There are four types:

  1. Another owner manager.
  2. A large perhaps national company which is listed on the Stock Exchange or whose long-term plans are to list on the Stock Exchange.
  3. An investor.
  4. One of your employees (or maybe several of them).

Selling to another owner-manager

If you are selling your business to another owner manager, they will probably have a very simple view of what your business is worth.

They will understand that they are buying net assets from you (the value of the assets in the company minus its liabilities) and that they are also buying the right to earn future profits.

The question they will want to consider is: how many years will they be prepared to work in order to get their money back for those future profits?

That number of years is the multiple that would be applied to your real profit to calculate your goodwill.

Uh-oh, jargon alert. “Real profit”. What does that mean?

The real profit is the amount of profit that your company is expected to make after it has paid somebody the market value salary for what you do. So that means that if you earn £50,000 per year from your business but the market value salary for what you do is £50,000, then the real profit is nothing.

That doesn’t always mean that your goodwill is valueless but will come on to that later. But it does mean that anybody looking at your company will think to themselves that they are not going to make any profit out of it based on the way it is currently working.

  • Who will manage your business whilst it goes through the sale process?
  • Is there enough money in the business to keep in running until the sale is completed?
  • Does a buyer need to be found and if so who will find them?  Will your partners be buying your shares – do they have enough money to do so?

But how do we work out what this real profit is?

We don’t have a crystal ball which can forecast accurately what the future profits are going to be. And therefore, we have to use historical information to help us.

Some businesses make really good profits, but it is based entirely on getting new contracts. If the owner of the business and all the connections that they have and their sales skills were to go it’s quite possible that these contracts will dry up. Therefore, someone might consider that their future guaranteed profits were minimal.

But many businesses are not like this. They have ongoing income through maintenance agreements or just regular customers that constantly come in the door. A change of owner is not going to alter that. So therefore, looking at the average of the last few years’ profits ought to give us a reasonable indicator of what future profits are going to be.

Of course, it might be that those profits are slowly decreasing, or it might be that they are increasing. That will impact on our estimate of the future profits or perhaps the multiple that we are prepared to apply. Either way, using that information should give us a reasonable idea what another owner manager might consider is a fair price.

Selling to a large or listed company

But there are other types of buyers out there and to get the best price for your business probably requires you to sell to a much bigger company.

Picture the CEO of a listed PLC.

His or her company might typically trade on a stock exchange with a PE ratio of let’s say 16. What that means is that the value of its shares are 16 times its annual profits after tax. Depending on how the market views the prospects of your company, that ratio could be even higher than that.

That CEO is probably rewarded based on how well the company’s share price does. So that depends to a great deal on the profits that it makes.

So now let’s imagine that as a CEO of that company has discovered another small company that makes £1 million profit per year after tax. That means that if they could add that company into theirs then the value of their company will go up by £16 million. So, if they were to pay £10 million for that company then although their cash reserves have fallen by £10million they are £6 million up overall.

That’s why a listed company is always going to pay more for your business than an owner manager.

Selling to an investor

For most companies it is not appropriate to look for this type of buyer.

They are fairly rare and they are pretty choosy about what they buy but they could be consolidating lots of businesses in your industry.

They might have a bank behind them lending them significant amounts of money albeit the bank is charging quite a high rate of interest.

They will be prepared to take risk but would want a good return on it. They will work on the basis that they are going to borrow most of the money to buy your company and will pay interest on that. Therefore, if they can pay an amount to you which means that the profit from your business minus the interest on that amount is still a good enough return to warrant the risk that they are taking then they might well take a chance on buying your business.

Management buyouts

Of course, the last scenario is one which is often a little bit more likely.

It may be that your business is quite hard to sell or perhaps you don’t really want to put all your customers in the hands of someone you don’t know. Perhaps the buyer might be right under your nose being one of your employees or even a collection of your employees.

Businesses are often sold to existing employees in what is known as a management buyout.

Because there is usually a high degree of trust between the parties, the deals are often far more flexible than they might be with a unknown third party. The valuations might be contingent on certain future results and could be paid over an extended period of time. There are all sorts of variations that can be built into the sale agreement to help either party.

Finding the buyer / seller win-win

The ideal situation is where the company being sold is worth more to the buyer than it is to the seller.

For example, if there was somebody out there in a connected industry to yours who has exactly the same sorts of customers that you have then they might consider buying your business even if your business doesn’t make much profit.

The reason is that they could potentially absorb your company into theirs (and perhaps wipe out a load of its overheads) but also they will then have all your products and services to sell to their customer base and they will have all of your customers that they can sell their products.

This is a classic example of a win-win for both the buyer and the seller and we have seen some really good sales achieved in this sort of situation. Sometimes of course even companies which are not making any profit can be sold for reasonable sums!

So what is your business worth?

Why is all of this important in understanding what your business is worth? Well because unless you consider what type of buyer is going to buy your business then you don’t know which formula to use.

A4G have an improve and grow session called: What is my business worth?

We will utilise the financial information about your business provided by you to work out some indicative valuations and then most importantly will sit down with you and run through the different ways that different types of buyers might look at your company.

The benefits of this service include that it helps you to start to identify the changes you need to make in order to maximise the value of your business.

If you want to find out what your business is worth and how you can increase it, come and talk to one of the Principal Advisers at A4G.

Want to find out more?

Call us on (01474) 853856 and we will put you in contact with one of our advisers, or send us an enquiry by clicking below.

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